Wednesday, November 15, 2006

SUMMARY:
- Stocks rally into the FOMC, stall, manage to hold some gains ahead of CPI
- FOMC seeing inflation around every corner.
- CPI takes on a bit more importance in wake of FOMC minutes.

Indices extend breakouts though FOMC minutes splash some water on the fire.

Some more merger talk (USAir/Delta), some decent earnings, and a strong NY PMI (26.7 versus 14 expected) helped keep the momentum from the strong Tuesday move brewing. Stocks ran higher out of the gates once more, shook off a mixed oil inventory report (oil more than expected, but gasoline & distillate about a million light & refinery runs down to 86.1%), and then sprinted higher to the FOMC minutes almost as if they had a death wish. You knew the FOMC was not going to be kinder and gentler, and sure enough, when it came out basically saying inflation was just around every corner, stocks were challenged to hold their moves.

Nonetheless they did manage to hold some gains into the close with some solid NASDAQ volume and decent breadth. Technically it was not a powerful session; the close off the highs spoke to that as well as the NYSE volume that slid a bit lower on the continued gains. Despite so-so internals, the indices continued their breakouts, putting some more nice gain in the bank as they stretched their moves. Really liked seeing that; last time NASDAQ broke out it gave it back so a few good moves strung together shows the buyers have a bit more staying power. Also, it is good to see these other indices come to the fore and help broaden out the rally just when the large cap NYSE stocks started to struggle a bit. Again, not bad action given a Fed that from its written word is pretty much scared of its shadow.

All of this is a prelim for the CPI out in the morning, and with the Fed clearly (at least in writing) trying to tell the market not to expect rate cuts, a strong number could do some damage. Of course, it seems as if the bond market is the only market worried about the future as the inversion Wednesday came close to 20 BP.

THE ECONOMY

Fed warns that all members are worried about inflation.

The minutes were chock full of fear of inflation. The Fed went out of its way to note that 'all participants' were concerned that inflation expectations would get out of hand if the core inflation rate (as measured by the CPI and PCE) remained outside of the Fed's comfort zone. What is driving this is a belief that the economy is overall strong and going to get stronger after this slowdown, yet inflation has not fallen with the decline. Well, as history shows us, inflation is not tied to economic strength. Inflation was high in the Great Depression, at least before deflation took over. In the 1970's the economy was a cesspool but inflation surged. Inflation depends upon how much money is in the system vis- -vis the economic strength. If there is too much, weak economy or strong, inflation crops up.

The problem the Fed has is that its dogmatic focus on a lagging indicator boxes it in with respect to its solutions. It gets into the perceptions game as it is now, i.e. worrying that the world won't think it is tough if it recognizes history and looks to leading, less understood indicators of inflation. The fact is, inflation peaked a year ago, and while the decline has been slow, it has continued its decline.

That more than anything else is what has the Fed concerned. It sees inflation is falling, hence the comments a month and more back about how inflation was not falling fast enough (Lacker et al). They want to see it tank, but if the Fed acted to make it fall flat it would have to drain the money supply and that would have very bad affects on the economy. Given Greenspan left money supply growing way too long and indeed even as he raised rates, the Fed has done about all it can to curtail inflation and keep the economy from rolling over. Thus the harsh talk to try and keep everyone very aware the Fed is worried about inflation as it waits out the lagging data, hoping it will finally start softening.

CPI is out Thursday morning, and unfortunately, despite the impressive declines in the PPI, they won't likely repeat in the CPI just yet. Thus the market will have to interpolate the Fed's minutes with the new data as well as comments from Poole re how Fed policy is 'about right.' It indeed appears the Fed is telling the market it is happy with how things are going but not to get excited and expect rate cuts while the inflation rate is still hitting long term highs. In short, the Fed is saying be happy you got a pause while we wait for inflation to start its fade.

THE MARKET

MARKET SENTIMENT

VIX: 10.31; -0.19
VXN: 15.4; +0.04
VXO: 10.35; -0.54

Put/Call Ratio (CBOE): 0.83; +0.02

Bulls versus Bears:

Bulls: 52.1%. Ticking down from 53.7% last week and also below the 52.7% rung up the prior week. Still flirting with 55%, the level considered bearish. Has caught the April high and is moving closer to the January peak at just over 60%. 55% is considered a bearish indication.

Bears: 26.0%. Moving the opposite from the bulls, bears fell sharply from 28.4% and 30.1% before that, continuing the faster decline. Down from the 37.1% hit in July (the highest level in this entire cycle, easily clearing the 34.4% hit in late June back when bulls and bears kissed, just missing a crossover). It remains above the 20% level considered bearish but is back to heading that way with more speed. Hit a new post-2002 high in that late June move, eclipsing the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005).

NASDAQ

Stats: +12.09 points (+0.5%) to close at 2442.75
Volume: 2.147B (+6.31%). Another volume increase as NASDAQ and SOX pushed their breakouts further. NYSE volume is lagging, but that is because the large caps have rallied ahead of everything else and not as much money is heading their way now.

Up Volume: 1.379B (-48.173M)
Down Volume: 749.663M (+229.923M)

A/D and Hi/Lo: Advancers led 1.62 to 1. Decent breadth and not bad after the solid performance Tuesday.
Previous Session: Advancers led 2.13 to 1

NASDAQ pushed its breakout further, something we wanted to see versus its last attempt that was thrown back rather quickly. It closed off its high, giving up almost half its move by the close after the FOMC minutes hit. Strong volume, well above average, pushed the action. A solid two weeks when looked at as a whole, and NASDAQ is getting close to the point it needs a bit of a breather, but it still ash room higher inside its channel.

SOX (+0.42%) pushed its breakout a bit further as well, but its move was more problematical, showing something of a doji after the surge. Not unusual after breaking through a key level, but want to see more upside out of this move before a test. If the CPI comes in tame it may show us another surge before that rest.

SP500/NYSE

Stats: +3.35 points (+0.24%) to close at 1396.57
NYSE Volume: 1.697B (-0.85%). Volume remained above average even if it was lower as SP500 and SP600 extended the Tuesday gains. Still solid trade so not nitpicking the amount.

Up Volume: 1.14B (+1.013B)
Down Volume: 542.629M (+120.429M)

A/D and Hi/Lo: Advancers led 1.64 to 1. Was a solid 2:1 until late in the session.
Previous Session: Advancers led 2.9 to 1

A push higher on solid volume that also gave back as many points as it gained, but with the FOMC minutes you could say it was not a ad session at all. This is particularly true when you consider it was really struggling before the Tuesday break to a new post-2002 high.

SP600 (+0.80%) was the leader, surging late as buyers looked smaller. Excellent surge that is carrying it toward the all-time high hit in May at 405.94 (closed at 402.31). Hard to complain about this move as it extends its nice Tuesday breakout.

DJ30

DJ30 gave back more than it gained on the session as the blue chips struggled to continue the Tuesday resumption of the upside break. As noted above, the blue chip NYSE stocks are still bit winded after their strong moves higher, and even with the Tuesday breaks to new highs it still has a lot of mileage behind it already. So, any continued upside is a bonus and we are looking at it that way.

Thursday is pretty much all about the CPI and how stocks react to a reading that in all likelihood won't show the same kind of improvement as the PPI. If it does we would likely see a surge early that would create some windburns with the rush. Even with that there would likely be some profit taking after such a move. Thus we would use a rush higher to bank some more gain.

The more likely result is that the CPI is in the same range as before and the market will have to reconcile the continued inflation pressure and the Fed's grave concern about it. The likely conclusion: the Fed is not going to cut rates but it is likely to leave them steady in the hope that inflation will, by the turn of the year, start to soften. Thus even if CPI is in line at 0.2% on the core the market can deal with it. May not jump up with joy but it can deal with it.

In any event, we will be looking for opportunity to take some gain when the opportunity presents. On an upside surge we will let it run then take some off the table on those positions that have put in good runs. There is nothing to indicate that the run is over, particularly with the breakouts from NASDAQ, SP600 and SOX, and thus while we will protect gains, particularly on option plays, any pullback will likely provide more upside entry points once again.

Support and Resistance

NASDAQ: Closed at 2442.75
Resistance:
2477 from January 1999
2493 is an interim peak from February 1999

Support:
2412 from June 1999 low
2384 is an interim peak from January 1999
The 10 day EMA at 2395
2379 is the October high.
2376 is the April high, the former post-2002 high
The 18 day EMA at 2375
2368 is the early October handle high.
2333 is the top of the Q1 2006 trading range (the January and mid-March 2006 highs)
2316 from interim tops in January and March 2006 trading range
The 50 day EMA at 2312
2300 represents some price support

S&P 500: Closed at 1396.57
Resistance:
1398 is a low from January 2000
1401 is a low from April 2000

Support:
1390 is the October high.
1389 is a low from November 1999
The 10 day EMA at 1384
1378 is a low from May 2000
The 18 day EMA at 1378
1371 to 1373 is the December 2000 peak and the January 2001 peak
1358 to 1362 mark a series of peaks from April 1999 to August 1999 high and the February 2002 low at 1360.
1354 from the early October consolidation
The 50 day EMA at 1354
1339 is the late September closing high
1334 is an October 1999 peak
1326.70 is the May 2006 high
1324 to 1329 from the October 2000 lows.

Dow: Closed at 12,251.71
Resistance:
8% above its 200 day SMA. Has been struggling since it hit near 8% above that level previously in late October. Tends to start about 10%, so this is a bit early but it has been a long run.

Support:
October high is 12,167
The 10 day EMA at 12,146
The 18 day EMA at 12,097
The 50 day EMA at 11,879
11,865 from the early October consolidation
11,750.28 is the prior all-time high
11,723 is the January 2000 closing high
11,670 is the May intraday high
11,642 is the May 2006 closing high
11,488 is the early September high.

Economic Calendar

These are consensus expectations. Our expectations will vary and are discussed in the 'Economy' section.